The Valuation of a Cable Customer

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Craig Moffett of MoffettNathanson recently set a valuation of an OTT customer from Sling TV at a quarter of the level of a normal Dish Networks customer. Since almost every small cable provider in the industry is interested in their valuation, I thought I’d talk today about Moffett’s numbers and how they might relate to cable valuation for small cable operators.

First the numbers. Moffett said that a normal Dish Networks cable customer is worth $1,100. That valuation reflects both the operating margin on Dish’s cable business as well as the average expected time that a cable customer stays with the company. Valuation in the industry in general is based on a multiple of operating margin – revenues less operating expenses. I don’t know what Moffett used as a multiple in this case since the valuation of Dish is muddled by the fact that they also own a mountain of spectrum.

Moffett set the value of a Sling TV customer (also operated by Dish Networks) at only $274. This low valuation tells us several things. First, the margins on Sling TV has to be significantly less. The company is obviously setting a low price to attract customers. And while Sling TV has a much smaller channel line-up than the big bundles at Dish Networks, Sling TV includes a lot of the most popular (and expensive) channels such as ESPN and Disney. I would also think that the valuation reflects a much higher churn for Sling TV. Customers are free to come and go easily and can buy service one month at a time. This contrasts to many Dish customers who get low prices by signing up for 1-year or longer contracts.

There are also other cost characteristics that are different for a satellite customer compared to on online customer. For instance, for a satellite customer Dish has to cover the cost of the satellite networks, the cost of the receivers used by customers. Sling TV has to instead just pay for transport of programming through Internet. Both parts of the business have to cover advertising and the cost of billing and back office. But it seems like Sling TV would have lower costs since customers must prepay by credit card. It’s hard to know which has a cost advantage, but I would guess it’s Sling TV. But Dish has millions of customers and would have some significant economy of scale.  

How do these valuations compare to the valuations of small cable providers? The big difference between terrestrial cable providers and Dish is having to provide a fleet of technicians in trucks and maintaining a landline network of some sort. Small cable operators also have to operate a headend and always face upgrades to keep up with the latest innovations in the industry. These costs are far more costly per customer for a small cable operator than what Dish is paying. I would think that due to economy of scale that Dish also has an advantage on costs like customer service, billing, etc. The equipment costs for customers are probably similar for Dish and terrestrial cable operators.

I have analyzed the books of a number of small triple play providers in recent years and if costs are allocated properly to products I haven’t seen one that has a positive margin on the cable TV product. While small cable systems generally charge more than Dish Networks they also pay more for programming. But the main reason that small terrestrial cable operators lose money is the work load associated with supporting cable TV. I’ve done detailed time studies at clients and have seen that in a triple play company that way more than half of the calls to customer service and the truck rolls are due to cable issues. If a small company allocates expenses properly between products, then cable is almost guaranteed to be a loser.

What does that mean for valuation? It’s probably obvious that if one of the major product lines of a company is losing money that the negative earnings pulls down the overall valuation of the business. Said more plainly, if the cable business at a small company is losing money, then that part of the business has no value or even a negative value. This is a conversation I have with clients all of the time, and most small cable providers have at least thought about the ramifications of dropping their cable product.

It’s not quite as easy as it sounds, because if somebody drops cable then they need to also pare expenses that were used to support cable. For a small company that means cutting back on customer service and field technician positions – something that small companies are loathe to do. Small carriers also worry that cutting cable will cost them overall customers, particularly if they are competing against somebody else that offers the triple play. It’s definitely a tough decision, but I’ve heard that as many as fifty small telcos have ditched traditional cable.

I’m also seeing for the first time that many new network operators are launching new markets without cable TV. Or they are instead looking at models where some external vendor like Skitter TV sells cable to customers.

Unfortunately, the cost of programming is still climbing fast and the margins on cable keep worsening for small cable operators. I expect that some time within the next five years or so we will reach a flash point where the collective wisdom of the industry will say that it’s time to ditch cable – and at that point we might see a flood of small companies exiting the business. But I don’t know of a harder decision to make for a small triple play provider.

Sell or Hold?

1854_gold_dollar_obvEvery telecom business ought to periodically ask the question of whether it should stay with the business or sell. Asking this question prompts you to take a measure of your business and to think about the future. One of the best tools to measure your performance is to periodically get a valuation. I recommend a valuation every three years. This gives enough separation in time to understand if the business is gaining or losing value over time.

A good valuation is going to be detailed enough to dig into the details and will find the real value to a buyer. Telecom valuations are no longer done on value per customer. Instead a buyer will offer a multiple of the cash flow that they will inherit after a purchase. A well-prepared valuation is going to start with your books and ledgers and will make adjustments to reflect the actual cash flow a buyer will see if they bought your company.

There are almost always expenses that would disappear if a company was sold. For example, there might be higher than normal salaries paid to owners in lieu of paying dividends. There might be benefits for executives that wouldn’t be paid by the new company. There might be company cars or other assets that won’t convey to the new buyer. There might be employees that are not expected to be retained by a buyer. In an actual sale the seller would want to acknowledge these sorts of adjustments, and so they should be reflected in a valuation.

One must also consider normalizing revenues. It’s not unusual these days to sell services on a long-term contract that have up-front payments. So if you sell things like transport to a cellular tower but only get such revenue in the years when the contract renews you need to adjust to show that as annual revenue at the appropriate level.

Getting a good valuation is only a start to looking at your business. A valuation will tell you about the overall health of a business, but it doesn’t tell you how to make your business worth more in the future. So along with a valuation I also highly recommend that you look periodically into the future to see where the business is headed. Take a look at the services you are selling today and see if those same revenues will be around in the future. For example, if you count a lot on cable TV or voice revenues you must consider that the customers from both of those products are disappearing each year.

I call this process of looking into the future a strategic review. You need to periodically take hard look at your business and ask yourself if you are doing the right things. Are you staffed right? Are you selling the right products? Are you marketing right? Should you outsource things done internally or bring external functions in-house?

It’s not always easy to look at your business critically and you ought to consider bringing in some outside advice to get a fresh set of eyes looking at your business. You can do this by hiring a consultant like me, and I regularly help companies take a hard look at themselves. But you can also get this advice elsewhere. You might know somebody who runs a telecom company that you know and trust who could give you the same look. But what you want is somebody who will ask the hard questions and who will challenge the assumptions that you take for granted. It’s very easy in a telecom business to get stuck thinking that the status quo will never change, but you don’t want to look up some day and see that you have lost a lot of margin and value and didn’t take steps to avoid it.

Finally, the really critical step is to use the information you learn. If your business is not meeting the goals you set for it, in terms of generating cash flow or growing in value, then you must decide what steps need to be taken to meet your goals. A valuation is a tool and not an end to itself. Only undertake valuation and a strategic review if you intend to learn from the process and are willing to deal with whatever you learn during the process.